How to properly use Apple's guidance to accurately forecast earnings

It seems that almost daily now there's yet another worthless article that incompetently tries to forecast Apple's fiscal Q1 earnings by taking a look at Apple's EPS guidance. The problem with that approach is that Apple's EPS guidance is entirely useless.

Understanding how to properly use Apple's guidance to forecast earnings will get you to within 5 percent margin of error. Yet, to get there you have to use the right methodology. Trying to extrapolate anything from EPS guidance simply isn't it.

The very first thing any good analyst should look for when forecasting Apple's earnings is the company's revenue guidance. Apple's revenue guidance is not only the most important and consistent line item in the company's overall multi-layered guidance, but it is by far the most important data point period. Those with a very strong background in finance can very accurately forecast Apple's full income statement simply by understanding how to interpret the company's revenue guidance. Yet, unlike Apple's revenue guidance, its EPS guidance is by far the most random, meaningless and inconsistent number which acts as nothing more than a red herring for the inexperienced.

The reason for this is actually quite simple for a financial analyst but complicated for the average Seeking Alpha contributor to understand. It demands more than a surface understanding of accounting and financial analysis as well as a highly specialized knowledge of the way guidance actually works. The problem is, that 99 percent of the entire financial community and 100 percent of the financial press is completely clueless when it comes to this issue. So that results in a lot of bad analysis being circulated.

In order to accurately forecast Apple's income statement, it requires a top-line down approach to Apple's guidance. You have to begin the analysis by looking at Apple's revenue guidance. A good analyst will be able to infer within a 1-3 percent margin of error what Apple's revenue will be in any given quarter using nothing else than Apple's revenue guidance.

From there, you use Apple's gross margin guidance in order to determine what the company will report in overall gross margin. Apple typically sandbags gross margin by 250 basis points +/- 30 basis points on a very consistent basis. Simply adding 250 basis points to Apple's gross margin guidance will lead to extraordinarily accurate results on a very consistent basis.

From there you simply add $50 million to Apple's OpEx guidance as Apple consistently under-estimates its expenses by about $50 million. That will get you down to operating income. Apple typically sandbags OI&E by $15 million. That will get you down to net income before taxes.

Recently Apple has been giving us the tax rate guidance almost perfectly. Simply multiply the tax rate by Apple's operating income and you arrive at a highly accurate net income number. After that, all you have to do is reverse engineer what Apple expects in outstanding diluted shares in the quarter by using simple algebra, and you will arrive at an EPS forecast that will very likely be within a 5 percent margin of error to Apple's actual results. That's the methodology we're going to develop below.

Our objective is thus two fold. First, we going to demonstrate how one can very accurately put together one of the top income statement forecasts that will beat every single Wall Street analyst simply by using nothing more than Apple's guidance. Secondly, we're going to show why the method of doing so requires one to simply ignore Apple's EPS guidance as being random, meaningless and distracting.